My bank Relationship Manager recently reached out to discuss the option of opting for a reduced Equated Monthly Installment (EMI) for my loan. While I appreciate the potential savings that come with a lower EMI, I am seeking your expert advice on the matter.
Would you recommend maintaining my current EMI amount to expedite the repayment process and own my home sooner? Or do you believe that opting for a reduced EMI and extending the loan tenure could be a more prudent financial decision in the long run?
I understand that a shorter loan tenure translates to fewer interest cycles and significant savings over the lifetime of the loan. However, I value your perspective on this matter and would greatly appreciate your input.
Advice by Animesh Hardia, Senior Vice President, Quantitative Research at 1 Finance.
The right way to make this decision is by aligning your personal finances with your psychology. Your behaviour and your personality play a very big role in making a financial decision. It should be the starting point of answering such questions - is the decision going to help you achieve peace of mind, or is it going to give a temporary reprieve and stress you in the long run?
It requires more 360-degree thinking: Do you have an emergency fund? Have you purchased the right amount of life and health cover? Is your asset allocation more concentrated in a few asset classes? Does real estate make up a big part of your asset allocation? How far is your retirement? Are you investing enough for your future? Are you paying too much of your income in EMIs? Are you overspending? etc.
The point that I want to drive home is that any income you receive needs to have a clear waterfall structure, with money first flowing to the bucket, which is most empty and likely to give you the most stress.
In your case, here's a waterfall structure for your income that you can follow:
1. First, focus on risk management
- Financial risk of not having an emergency corpus or health/term insurance.
- Risk of running into liquidity issues because of high-cost loans and EMIs.
2. Then, fix your asset allocation
- Reducing concentration by diversifying your investments across asset classes.
- Aligning your investments with the financial goals you want to achieve.
3. Then, spend while keeping them under control
- Limiting your discretionary expenses to a sustainable level.
- Finding ways to reduce your overall monthly expenses.
To conclude:
> 'Opting for a reduced EMI and extending the loan tenure' could be considered if you're living paycheck to paycheck and feeling stressed about your monthly expenses, or if you're young and still rushing into repaying your loan aggressively while avoiding investing in other asset classes.
> 'Maintaining the current EMI amount' might be a better option if you're investing regularly and building a diversified portfolio, and your monthly expenses are under control.
> A bonus suggestion is that India is currently entering a rate-cut cycle where the central bank (RBI) is expected to gradually bring the repo rate down to boost economic activity. This should automatically result in a reduction in tenure on floating-rate home loans if EMI is kept unchanged.
> Connect with a qualified financial advisor if making these decisions is taking up a lot of your time and ultimately results in procrastination. Their job is to understand your situation, evaluate your options, and help you achieve results sooner—all focused on your financial well-being.